More cuts may be on way -- but recession still looms

P-I NEWS SERVICES

Published 10:00 pm, Tuesday, January 22, 2008

The Federal Reserve, confronted by deepening panic in global financial markets about a possible recession in the United States, struck back Tuesday with the biggest one-day reduction of interest rates on record and at least temporarily stopped a vertigo-inducing plunge in stock prices.

And there may be more action. In a statement accompanying the Fed's decision, announced about an hour before the stock market opened for trading, officials hinted that they may reduce rates again at their scheduled meeting next Tuesday and Wednesday.

Economists, though, said a recession is still a possibility.

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Interest rate reductions are one strategy the Fed has used in previous crises to help the economy recover. A rate cut tends to spur the economy by making it cheaper for businesses to borrow money. It could also lighten the burden on people with credit card debt and with mortgages that have adjustable rates.

Commercial banks responded to the Fed's action on the funds rate by announcing similar cuts of three-quarters of a percent on the prime lending rate, the benchmark for millions of business and consumer loans. The action will mean the prime lending rate will drop from 7.25 percent to 6.50 percent.

The unexpected decision came after a rare, hastily called policy meeting by video conference Monday night, and it reduced the Fed's benchmark overnight lending rate by three-quarters of a percentage point to 3.5 percent.

The Fed's move was prompted in part by turmoil in global markets Monday, a holiday in the United States. Shortly after lunch in Washington, D.C., that day, Fed Chairman Ben Bernanke canceled a planned trip to New York and started organizing the impromptu meeting of Fed officials who decide interest rate policy.

The magnitude of the Fed's rate cut helped reverse what began as a horrendous day in the stock markets. European and Asian stock prices had already plunged for the second day in a row, and the Dow Jones industrial average fell 464 points -- about 5 percent -- as soon as markets opened in New York.

By the close of trading Tuesday, stock prices, after gyrating wildly for hours, had clawed much of their way back. Shares of banks and insurers of mortgage-backed securities, which had been battered in recent days, were among the day's biggest gainers.

Still, it was a nerve-racking day on Wall Street, with the Dow ending down 128 points, or about 1 percent. And even after the rebound, the major market indexes are down about 10 percent so far in January and even further off their recent highs in October. The Nasdaq composite index, which mostly reflects technology stocks, is off 18.3 percent.

The move came too late to help Asian markets Tuesday, which had closed for the day, but stocks rose Wednesday, rebounding from steep losses the previous two days.

Japan's Nikkei 225 index was up 1.7 percent in afternoon trading after jumping 3.4 percent earlier, recouping some of its 9.3 percent loss the past two days. Australia's benchmark index rebounded 4.4 percent, snapping a 12-day losing streak. In Hong Kong, the Hang Seng index -- which had plummeted 13.6 percent the last two days -- surged 7.5 percent at the opening before trimming gains to be up 5.3 percent by midday.

In addition to cutting the funds rate, the Fed said it was reducing its discount rate, the interest it charges to make direct loans to banks, by a similar three-quarters of a percentage point, pushing this rate down to 4 percent.

The Fed's move came as President Bush and congressional leaders pledged to work together on a bipartisan fiscal measure to jolt the economy with about $145 billion in tax incentives.

Economists said it remained far from clear that the United States will avoid a recession, either because the Fed and the Bush administration had moved too slowly or because the economy's woes were too acute to solve so quickly and painlessly.

"This is a cure for the wrong disease. It makes everybody feel good, but it's not going to have any ongoing benefit," said Daniel Alpert, managing director of Westwood Capital LLC. "We need to get ourselves out of a mountain of debt and overvalued properties."

The markets worry that consumers are not in a position to spend the country back into solid growth, because they have been cutting back rather than borrowing or spending more.

Citigroup, citing the severely depressed housing market, the credit crunch and high energy prices, predicted Tuesday that the economy was about to start shrinking and would barely eke out any growth for 2008.

Fed officials stopped well short of such gloom and doom, but they made it clear they had been alarmed by both worsening data in the United States and the worldwide stock panic that began Monday.

"Appreciable downside risks to growth remain," the central bank said, its most forceful acknowledgment yet that the U.S. economy is on the brink of a recession as a result of a perfect storm of the severe downturn in housing, the fallout from soured mortgages and the added blow of high oil prices.